Wed, Jan 19, 2022

New Models for Financing and Financial Reporting for European SMEs: A Practitioners’ view – Presentation –

  • 02/15/2019 - by Razvan Hoinaru

This book looks at the 23 million registered Small and Medium Enterprises (SMEs) that make up 98 per cent of the EU economy. Addressing the high end of SMEs in terms of new models for SME funding and financial reporting, this merged way of looking at SMEs reveals a ‘myopic’ thinking in terms of net present value and (future) cash flows generating short-termism and low-risk appetite for business. This is not an accounting issue, but rather a preference toward certain financial tools. A segment of SMEs, the ones that seek new ways of funding possibilities, as well as modern technologies (MTFs listing, the blockchain, ICOs, etc.) do require, even without knowing, IFRS for SMEs. This book reveals how market conditions impact the financial performance and sustainability of SMEs and also generate innovative policy interventions and financing strategies for SME integrity and efficiency. The authors frame their arguments in the context of the Capital Markets Union, looking at the Innovation Triangle, SME growth ecosystem and business models. They conclude by advocating for closing the circle of financing and financial reporting for SMEs while considering if new financial models of financing and financial reporting are good for all the SMEs or only for some. The economy is being shaped by new models of financing and financial reporting.

The key concept of this book is the European Small and Medium Enterprises (SMEs) and is looked at in two parts: finance and financial reporting. Editors, Eva Kaili as a Member of the European Parliament, Dimitrios Psarrakis as advisor of Economic and Monetary Policy at the European Parliament and Raz van Hoinaru as policy consultant in the European Parliament and researcher, decided on this perspective as money matters and a complete image, external and internal, is provided in such ways. Funding to SMEs is done from the external channels like investors or markets to the company, while financial reporting presents an inside-out perspective to investors and markets. Present practices of financial reporting, especially fair value, lead to a financialisation of accounting and in effect improved communication between the company, economic markets and financial markets. The framework of the European Union’s Capital Markets Union is used to consider old and new methods of financing, public and private, understood via the new financial reporting methods: IFRS for SMEs.

As Valdis Dombrovski, Vice President of the European Commission is pointing out in the foreword of the book, the Small and medium-sized businesses (SMEs) are the backbone of the EU economy. Not only do they employ two out of every three employees, but they also produce 57% of value added in Europe. Start-ups in particular play an important role in job creation. Young firms account for an average of only 17% of employment, but they create 42% of new jobs. Finally, smaller companies working on innovative business models and new technologies today are the seeds that will ensure Europe stays competitive also in the future. For all these reasons, the success of start-ups, scale-ups, and other small and medium-sized firms is crucial to the future of jobs and economic growth in Europe.

If we want SMEs to succeed, we must ensure that funding can flow from investors to entrepreneurs and small business owners. That is why the European Commission launched the Capital Markets Union, the flagship project to develop and interconnect European capital markets. Also, there is a need to ensure that investors have clear and standardised information while keeping the reporting burden for non-listed companies as low as possible.

Accordingly to the political, business and accounting perspectives, throughout the book, the word SME is conceptualised slightly differently. Some authors seem indifferent of any definition, others used the official EU definition, though thinking more in terms of capitalization, rather than annual revenues or number of employees. These authors had in mind new business types that do not only have distributive effects but also provide a new framework for risk diversification at the high end of SMEs world. The literature review revealed that some studies do not use the EU definition either, and use another approach, where size matters, but more important is the business model, management knowledge and skills in terms of financial markets (which are different from economic/capital markets). This happens as recently, SMEs experience an unprecedented speed of change, is a very heterogeneous world and scholars use the generic term, not specifically mention what segment from the SME concept they refer to. In the end, we want to underscore the importance of SMEs world in terms of finance and financial reporting and the link in between them, by presenting the two parts of the book.

The first part of the book: Financing opens with the new financing environment of the European SMEs. The contributors adopt an instrumental, policy-practical approach and bring to the readers the current discourse of the European Policymakers and financing institutions. The fundamental changes in the financing of the European SMEs can be better examined in the light of the Capital Markets Union (CMU). CMU is a flagship initiative of the Juncker Presidency that was announced in July 2014. The aim is to introduce a more vibrant environment for market-based finance and improve the integration of the capital markets of the 28 Member States. The task was not only economically but also politically challenging, given the Continental Europe’s heavy reliance in bank originated financing and the variegated capitalist traditions of the European countries.

The economic rationale behind the CMU initiative was that a coherent and functionally harmonized financial ecosystem like the one proposed, would (1) accelerate capital mobility from the EU and abroad as well as the intra-EU cross-border flows, (2) improve stability through dispersion of risk and minimization of financial concentration to banking institutions, and (3) improve liquidity and the diversification of financing sources through deepening of the financial integration and increase of competition.

CMU is one of the policy-sectors of the EU that indicates significant “organic growth” with vast implications to the European SMEs landscape. As CMU evolves, the policy priorities evolve drastically as well. The Commission announced in 2017 nine new priorities for the CMU among them: (1) the strengthening of the regulatory powers of the European Securities and Markets Authority (ESMA), (2) the increase of the support to initial offerings for investment firms through the creation of an agile regulatory framework that supports SMEs listing on public markets, (3) the drastic integration of financial innovations, including FinTech, crowdfunding and ICOs, (4) the acceleration of cross-border investments through the improvement of the framework of the Alternative Investment Funds (AIFs) and the Undertakings for Collective Investment in Transferable Securities (UCITS) and (5) the strengthening of the local capital market ecosystems.

In a wider perspective, CMU can be seen as a step towards a democratized financial system, where the concentrations will be smaller, the investment barriers will be lower, and the access of the small players to capital will be greater. This reflects not only the demand of the European businesses for a real European economic union; it also reflects the significant technological developments that favour financial disintermediation. Crowdfunding and blockchain-empowered models of Initial Coin Offerings (ICOs) reflect these technological changes and the new regulatory challenges that nobody can ignore. The editors of this volume are actively involved through their work in the Economic and Monetary Policy Committee of the European Parliament, in the transition to a new financial era where investment will not be a “job of specialists” but a function that blends “specialists’ analysis and financial decision-making” with the dynamics of the “wisdom of crowds”.

One key word of this transition is “harmonization”. EU, being a fragmented area of 28 Member States (soon 27), lacked the necessary conditions that would allow the optimal allocation of capital and risk throughout the Continent. Harmonizing policies are now put in place to improve both the flows of capital and financial information. It is expected that European SMEs, will be the biggest beneficiary of this transition.

The contributors of this volume, despite their different professional origin, from practitioners to academics, all converge to a set of very specific assumptions. First, they all agree that Europe needs to revisit its economic growth model. They believe that SMEs were, are and will be in the core of any future growth model, but the orientation of the SMEs should change and adopt a more innovative and technologically-savvy approach. Growth is a function of competition and competition is facilitated only by genuine and deep innovation. The question is who is going to finance this innovation effort? Second, all the contributors explicitly or implicitly highlight the problems that the post-crisis bank regulations imposed in the financing conditions of SMEs. Basel III and CRD IV increased the capital requirements of the banks and this affected disproportionally the SMEs in Europe that they were highly relied on traditional bank instruments.

The financing gap that the post-crisis macroeconomic environment created is the core concern of all the contributors. They all agree that the EU should gradually move to sources of private and public equity as well as alternative financing vehicles. We can identify two major groups in this trend. There are authors who emphasize the shift from the global-banking-based financial intermediation to a more investment-banking-based financial intermediation approach. There is also another group of authors who believe that on top of that, it is also important SMEs to harness the new technological opportunities that allow us to move from financial intermediation to financial dis-intermediation. SMEs should not ignore these developments. In our view, a balanced approach that brings together traditional and innovative financial instruments is the most suitable. Fintech applications, based on cloud, machine learning and blockchain can be combined and build a significant financial infrastructure in Europe. This infrastructure will allow the emergence of synergies between SMEs, Fintech firms and traditional financial institutions that will accelerate the mobilization of capital to SMEs and the dispersion of risk among multiple actors, reducing thus the risk concentrations and the systemic financial dangers.

The second part of the book: IFRS for SMEs deals with financial reporting for SMEs, which is an important part of the exchange of information between companies and investors. And it is also a piece of the puzzle for resolving the difficulties for SMEs to access finance, through the International Financial Reporting Standards (IFRS) for SMEs and challenges that both SMEs with their managers and IFRS/IASB face. The author’s approach is pro-IFRS for SMEs as they believe that IASB provided a high-quality set of financial reporting standards that are fit for purpose, improve transparency, increase harmonisation and comparability. IASB acknowledged the need for a separate standard for SMEs derived from full IFRS though difference could arrive in between group’s accounting practices and subsidiary’. This customised approach may look like a light version of the IFRS, however, it has its own inner complexities. This set of standards work for companies that do not have public accountability but are developed in the public interest, to address real economic settings, like MTFs listing. SMEs should disclose information in such a way to ensure investor protection, which seems to be the purpose of IFRS, alongside with understandable, articulated and high-quality accepted information disclosures for the use of the company itself. Therefore, a single set of accounting standards was developed for the backbone of the EU economy, providing not only understanding but also simplification of costs, although some commenters put into question the price for trained professionals.

Following the framework of the book, accounting solutions are thought about to achieve CMU’s ambitions. Accordingly to the CMU Action Plan accounting plays an important role in future growth. This was expected as markets are dynamic, new technologies and channels of business finance are invented and accounting must keep up and play its role. It makes sense for companies to disclose information under one standard. The use of the IFRS for SMEs standard make business environments more attractive to international investors.

The current accounting has changed, the assets and liabilities of the company are not any longer subject to internal control, but react to market value, and adjust themselves according to future earnings perspective and investments and investor’s needs. It is interesting to see how there is an accounting logic, that is different from an economic one, but still part of it. It is true that preparers and investors have different perspectives, while management may or may not base their decisions on financial reporting numbers. Along with or among with shareholders needs SME disclosures can hiddenly take into consideration stakeholders’ basics. As standards are principle-based, there is a difference in between the standards as such and the interpretation and use of standards.

The five chapters of this second part of the volume, even though might be named similarly, have a different approach, each of them touching on something else. Obviously, they are all centred on the IFRS, with the following perspectives: technical, SME’s, or considers the market as a whole. For a better understanding, also a parallel in between full IFRS and IFRS for SMEs is provided, in comparison with full IFRS and with local GAAPs. Some chapters are more informative in nature, while others are more critical, putting forward business and policy recommendations.

The book has a practitioners’ perspective and aims practitioners, professionals, policy-makers, consultants and advanced academic level. Such a view is rare and stands isolated, as inside information is hard to get anyway, not to mention a proper inside perspective put in writing by the practitioner. Nearby approaches are applied research, empirical research, professional impact assessment or practical guides. The research design tried as much as possible to keep a unitary tone through the book, as in our case professional perspective sometimes means educated opinions put in writing of what a practitioners’ do day by day, and their work varies. Accordingly, this book did not adopt such an approach were professionals were questioned, and authors translated their input in an academic style. As the book can be used by academia as well, there was an academic touch on two chapters, authored by scholars. For example, the Literature review section provides further reading examples of article and books, but also of professional studies and political reporting, having a balanced approach, keeping this book perspective. Each author was free to write on his and her’ subject matter and is responsible for the opinions and data presented. The editors designed and structured the book, giving it a direction, and have our own contributions, they tried as much as possible to provide the reader with ‘real life knowledge’, timely information upon the new developments in the financial sector and financial reporting. Because this writing has a practitioners’ view some chapter lack footnotes as the knowledge provided is based on the work experience of the authors.

The book should be gradually read in order to get a complete picture. Chapters may look like stand alone and make sense in themselves, but each chapter adds on top of the previous one. Accordingly, chapters’ order was specifically chosen the way it is. The Literature review chapter has an extra uniting role giving coherence to the book, and also positioning the current research among specialised studies. The key focus is the SMEs and the books start to present the framework in which SMEs act: the SMEs ecosystem, important SMEs drivers like innovation, models of finance for SMEs, finance of SMEs, and how finance is registered accordingly to IFRS for SMEs. Some chapter may look similar, but they argue from a different perspective: SMEs and respectively financial reporting.

As a conclusion, you are kindly invited to read these practitioners’ view to understand the current changes and challenges.

The editorial team and contributing authors

Razvan Hoinaru,

Business minded, policy consultant by vocation, an economist by education, and historian by heart, all together and all separately recommends Razvan as a ‘man of social sciences and society’. His work has spanned across public affairs agencies, government bodies, private companies, lobby and Parliament in-house policy development and advocacy

European Small and Medium Enterprises, Financial Reporting, SME funding